Time to Sell Apple, at Least for Index Investors

Given Apple's success with the iPhone 4 and iPad 2, analysts are now positing that Apple (AAPL) is getting closer to becoming the most valuable company on the planet. Perhaps it will be the iPhone 5 this summer that pushes it to number one. The company's very success, however, triggered what could be a setback for its stock: NASDAQ announced that it is cutting Apple's weighting in the NASDAQ 100 from 20.5 percent to 12.3 percent. Apple shares fell 0.7 percent on the first trading day after the announcement, while the index itself was virtually flat.

The NASDAQ 100 stocks are the 100 largest and most actively traded stocks on the NASDAQ stock exchange, and happen to be very tech weighted. More than $330 billion in index funds and $40 billion in ETFs are tied to this index.

What this change means
Though I don't know how Apple will perform going forward, I'm not willing to bet my retirement nest egg on it. There are three significant implications from this story, however.

Diversification. If you own an index fund where one stock comprised 20.5 percent of the weighting, you are not diversified. In fact owning 100 companies is not enough diversification, especially when they are very heavily skewed to one industry - technology in this case.
Costs. All NASDAQ 100 index funds will now have to go out and sell Apple and buy greater positions in many companies. These costs are not part of the expense ratio of any fund. The same thing happens when a company is replaced by a new entrant into this, or any other, index.
Taxes. When the funds sell Apple, they will recognize a taxable gain. Even if you don't sell the shares of your fund, the IRS may require the fund to pass on that tax liability to you.

My take
Having too much in any one security is taking too much risk, so I happen to believe this change is a good thing.

And for the true indexers, this is an non-event. Owning a total US stock index fund owns thousands of companies in all industries. It translates to more diversification, lower costs, and less taxes. Apple happens to be 2.07 percent of this index, which is more than enough eggs in that one basket for me.

Don't get me wrong, I love my iPad and happen to think Apple is a great company. But great companies do not always make great investments. Another great company, called Tivo, changed my life by allowing me the luxury of being able to watch a program whenever I want in a third less time. I'm just glad I held my investment to the weighting in the total index fund.

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Allan Roth

Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.

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